As large cap gets larger, can the tech rally continue?

Technology shares have led US stocks to record highs and are expected to continue to rise, but as market value becomes concentrated in the largest companies, some are beginning to look for the next rally leader.

According to Reuters, the technology sector of the S&P 500 .SPLRCT has risen roughly 20 per cent so far in 2017, led by Apple (AAPL.O), Alphabet (GOOGL.O), Facebook (FB.O) and Microsoft (MSFT.O).

The only other company with comparable gains in market value this year is Amazon (AMZN.O), a market darling not in the tech sector despite being a big player in cloud services and data storage.

"These are the dominant players in their specific spaces and the hottest areas in tech," said Daniel Morgan, senior portfolio manager at Synovus Trust Company in Atlanta, highlighting their exposure to the cloud and artificial intelligence.

"You will continue to see money flowing into those names. People want to be exposed to the hottest areas," he said.

Active funds have continued to throw their money behind the leaders with a record overweight on the technology sector, according to BofA/Merrill Lynch data going back to 2008.

But more than a third of the 2017 gains in the S&P 500 have come from these five companies, and the concentration of the advance has some investors jittery.

"Given how significant the (large cap) leadership has been year to date, I kind of think you need to find another group to produce that leadership," said Jim Tierney, chief investment officer of concentrated US growth at AllianceBernstein in New York.

Echoing Dell[DI.UL], Cisco (CSCO.O), Intel (INTC.O) and yes, Microsoft itself, the leaders of the Y2K tech boom, these new "five horsemen" have added more than $612 billion in value to the stock market this year. Their 2017 gains alone could buy the 85 smallest companies of the S&P 500.

Their combined value, near $3 trillion, is not far from the market value of all the other components of the Nasdaq 100.

NOT THAT EXPENSIVE, BUT...

This tech rally has come hand in hand with heightened expectations for profits. Investors are currently paying $18.50 for every $1 in earnings expected over the next 12 months in the sector, compared to the more than $40 they paid during the dot-com bubble and even the $20-plus seen during the most recent market peak in 2007.

Tech sector earnings are expected to grow 11 per cent in the second quarter after rising near 21 per cent in the first, according to Thomson Reuters I/B/E/S data.

However, with gains of more than 33 per cent for Apple, Facebook and Amazon, near 25 per cent for Alphabet and 15 per cent in Microsoft, compared to a gain of 8.5 per cent for the S&P 500, the room for more upside is declining.

Despite expecting gains upward of 20 per cent for the rest of the year on the so-called FANG stocks - Facebook, Amazon, Netflix and Alphabet - and their ilk, analysts at Fundstrat recommended in a Friday note balancing portfolios by scooping up the year's underperformers: banks, energy and telecoms.

They are not alone in searching for exposure outside technology.

"We're most overweight in technology but I don't want to stay too long at the party," said Alan Gayle, director of asset allocation at RidgeWorth Investments in Atlanta.

"What I'm watching for is an opportunity to lighten up on tech exposure and put it into some of the more cyclical areas," he said. "Financials are going to be catching a tailwind."

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